The Future of the Euro: Why Sentiment Alone Can’t Save the Union

A man looks at job adds in the window of an employment office in Milan, Italy, Monday, April 2, 2012. Unemployment in the 17 countries that use the euro hit its highest level since the currency was introduced back in 1999.

Being an American journalist reporting on the troubles of Europe is sometimes an ego-damaging experience. I regularly encounter economists, officials and other Europeans who take the attitude that we Yanks just don’t understand the euro. Americans, in their view, simply analyze the euro based on its perceived benefits and costs. But, I’m told, the euro is much more than a mere economic instrument. It is a symbol of the grand mission of European integration, a tool to ensure democracy and peace on a continent too often ravaged by war. The euro, therefore, means more to Europe than mere mathematical calculations of debt and growth can tell us, and the leaders and voters of the euro zone value the common currency based on what it means to Europe as much as what it does for Europe.

To this I say: They’re kind of right. I am guilty as charged – analyzing the euro zone in purely economic terms and often disregarding the bigger picture. I have to admit to being routinely baffled by the level of devotion and commitment Europeans display towards the monetary union, despite the pain and suffering it is bringing to a large swath of Europe’s populace. Even though governments have fallen and political careers ended as a result of the debt crisis, those taking their places have been just as pro-euro – in some cases, like Italy’s Mario Monti, they areeven more loyal to the cause. On a regular basis, the 17 countries that use the euro manage to somehow overcome their varied and often competing interests to forge sweeping agreements to try to strengthen it. Compare that to the gridlock blocking decision making in the U.S., with a mere two major political parties. Yes, the Europeans have been willing to endure far greater economic and political agony in the name of the euro than a Yank like me can possibly comprehend.

Yet at the same time, I have to wonder if that commitment will be enough to preserve the monetary union. Or will the weight of Europe’s economic problems eventually overwhelm the emotional and political connection Europeans have to the euro? In other words, will the euro’s fate be decided by Europe’s attachment to the idea of the euro, or by economic reality?

A year ago, I would have said with firm determination that the euro was ultimately doomed. Now I’m not so certain. Ultimately, however, it is money that makes the world go around. I say economics wins out in the end.

The simple reality facing the euro is that it is an economic catastrophe. Whatever its perceived political value, the euro was also supposed to be part of a grand agenda to make Europe economically vibrant and able to compete with the U.S. and a rising Asia. It has done just the opposite. Europe is the sick man of the global economy, heading into a double-dip recession, and begging China and other emerging nations for handouts. Looking solely at the economic wreckage, you’d think Europeans would be running from the monetary union in a mad panic. Three countries have already been bailed out by their neighbors – Greece, twice – and more could well be on the way. Those bailouts are potentially putting a big burden on taxpayers of the stronger nations, such as Germany and the Netherlands. The economies of Spain, Italy, Greece and Portugal are all expected to contract in 2012. Many others, including Germany, France and Ireland, will post only minimal growth. Unemployment in the euro zone is at a record high – more than three years after the financial crisis began. Nearly one in four people in Spain are jobless. Europe’s banking sector has come under severe strain, alleviated only tempoarily by emergency intervention by the European Central Bank.

The euro, of course, can’t be blamed for all of these economic woes. A good deal of mismanagement took place in a large number of euro zone members – whether the fiscal irrationality of Greece or the housing fiasco of Spain. But the euro can’t be absolved either. By locking together economies with greatly diverse levels of costs and competitiveness, the euro contributed to the huge internal imbalances that sit at the foundation of the debt crisis. The convergence brought about by the euro’s introduction (in, for example, interest rates) made possible the ballooning of debt in places like Greece. Now the euro is making escape from the debt crisis more difficult. Without control over their own currencies, weaker countries can only improve their prospects through the excruciating process of deflation of wages and costs. The policies imposed by the euro zone to combat the debt crisis have also made matters worse by suppressing any hope of economic recovery. The obsessive insistence on austerity is tanking growth throughout Europe, increasing unemployment and making deficit and debt targets harder to achieve.

The leaders of Europe have so far done little to address any of these underlying economic problems. Unwilling to accept the true economic problems caused by the euro, Europe’s leaders have routinely underestimated and misunderstood the economic causes of the debt crisis, and have thus routinely misfired in resolving it. The issue of imbalances almost never comes up. The leadership in Germany and other politically powerful nations has been deaf to calls for pro-growth efforts to counteract the growth-killing impact of austerity. Steps that could help alleviate the crisis – like eurobonds – have been rejected by Berlin. Under previous ECB President Jean-Claude Trichet, the central bank, paranoid about inflation, took the insane step of raising its benchmark interest rate, suppressing growth and making the pain of adjustment in the weaker economies that much more severe.

With no assistance from the greater union, the brunt of the efforts to quell the debt crisis has been dumped onto politicians in its weakest members — Greece, Portugal, Spain, Italy and Ireland — while everyone else sits back and watches. So far, the leaders of these countries have shown a surprising amount of guts in imposing unpopular reforms and austerity programs in favor of the euro. After Spain admitted it would miss its budget deficit target earlier this year, Prime Minister Mariano Rajoy, under pressure from his neighbors, introduced yet another biting program of cuts, even as the economy slipped back into recession. And what benefits have these governments seen from following euro-zone mandates? Not much. Portugal, despite committing to a firm reform effort, could well be headed for a second bailout like Greece. Spain continues to see its joblessness and debt increase while its borrowing costs remain high. Since the euro zone overall isn’t seriously addressing the true economic problems of the euro, the efforts to solve the debt crisis are simply not working.

It should come as no surprise, then, that those brave politicians who have stood up for the euro have paid the price. Governments in Portugal and Greece fell. The ruling parties in Ireland and Spain lost elections. After Italy’s Prime Minister Silvio Berlusconi resigned amid the spiraling crisis, his successor, Monti, has been watching his approval ratings drop. Those determined politicians standing by the monetary union are dropping like flies.

No wonder, then, that they are staging a mini-revolt. Monti and Rajoy have both called on a change of euro-zone economic policy, towards a pro-growth program to help struggling economies dig out from under their debt loads and create jobs. France’s likely next president, François Hollande, has joined in, promising to renegotiate a fiscal pact which enforces stricter rules on debt and deficits, agreed to by euro zone members earlier this year. Rajoy, Monti and Hollande are in essence asking their counterparts in the rest of the euro zone to show the same degree of political commitment to the euro as they have.

The rest of Europe must finally back its rhetorical commitment to the euro with real action – or the euro could well suffer the consequences. That means implementing pro-growth reforms across the monetary union and steps to reduce in-zone trade surpluses and deficits – entailing sacrifices by its strong as well as weak members. If not, the economics of the euro could come to destroy those very political and emotional attachments Europeans have to the euro. The pro-euro establishment could open the door to anti-euro political movements, now on the fringe, to take a bigger – and perhaps determining — role in European politics. (They are already flexing what muscles they have. The Dutch government recently collapsed after the anti-euro Party for Freedom pulled out of the ruling coalition in protest of budget cuts to meet euro-zone deficit targets.) The level of public anger over euro-zone economic policy is clearly growing. That sentiment was nicely expressed by Spain’s José Ignacio Torreblanca, head of the European Council on Foreign Relations in Madrid, in the Financial Times:

What is outrageous is that, while Spaniards face recession and soaring unemployment, Jens Weidmann, the Bundesbank president and European Central Bank council member, sits back and says that 6 per cent interest rates for Spanish sovereign debt “are not the end of the world”. At the same time, Nicolas Sarkozy campaigns for re-election by claiming his rival Mr Hollande would replicate Spain’s disaster should he make it to the Elysée…Something must be wrong in the EU when a pro-Europe, pro-austerity conservative government is ignored by Berlin or, worse, humiliated by France…Now, Europe is about asymmetries in power and fear for the future. Europe now resembles Thomas Hobbes’ description of man’s life in its natural state: “poor, nasty, brutish and short.” Two years on, not a single growth measure has been adopted. Time to say: basta!

If Europe doesn’t fix the economy of the monetary union, the economic problems of the euro zone could undercut the political will to save it. That process may already be starting. Whatever Europeans like to think the euro represents, in the final analysis, it is an economic instrument with economic consequences. And the euro will live or die based on its economic results and impact. I guess that opinion still makes me a Yankee.